My philosophy is that it is hard, but not impossible, to beat the market, and that it is easy, and imperative, to save on taxes and money management costs. I graduated from Harvard in 1973 with a degree in linguistics and applied math. I have been a journalist for 40 years, and was editor of Forbes magazine from 1999 to 2010. Tax law is a frequent subject in my articles. I have been an Enrolled Agent since 1979. You can email me at --williambaldwinfinance -- at -- gmail -- dot -- com.

Paying For College: A Tax Dodge For College Students

Why this country can’t have a flat tax: Higher education would suffer.

This is a set of instructions that will enable you or a loved one to claim a little-known tax benefit that will help pay for a college degree. Read carefully, because tax rules must be followed conscientiously and the sequence gets a little complicated. It involves adjusted qualified education expenses (AQEE), an exclusion phase-out, compound interest and American Samoa.

The tax benefit is called the Education Savings Bond Program. I read about this program in IRS Publication 970.

The idea is that you buy savings bonds when your kid is born and the interest compounds until the bonds mature (20 years). You cash in the bonds and use the money to pay tuition. If you qualify for the tax benefit, the interest income is free of tax.

More precisely, it may be partly free of tax, depending on your income and on how much of the bond proceeds go to tuition and fees.

Example. Suzy Creamcheese cashes in bonds worth $10,400, but has only $8,320 of AQEE. Yes, you could be sending your kid to an expensive private college and still have only $8,320 of qualified expenses, since the qualified expenses are what’s left after subtracting room and board, books, distributions from 529s and scholarships.

Since she’s using only 80% of the bond proceeds for AQEE, Suzy can exclude at most 80% of her interest.

That partial interest amount is then subject to a phase-out. The exclusion phases out if Suzy’s income gets too high.

To do the phase-out on Form 8815, Suzy first needs to calculate modified adjusted gross income.

That’s simple. You take income. Then you adjust it. Then you modify it.

The Internal Revenue Service spells out the modifications in its instruction sheet. Suzy has to add back the deduction for domestic production activities. There’s also something about “interest expense attributable to royalties and deductible on Schedule E, Supplemental Income and Loss.” Then Suzy adds the exclusion of income by “bona fide residents of American Samoa.”

Don’t skip this step. There’s probably an IRS prison farm in Mississippi where people are doing hard time for not adding back the Samoa money.

Suppose the modified adjusted gross income comes to $129,250. If Suzy is filing jointly, she subtracts this from $139,250, then divides the result by $30,000. The resulting fraction, one-third, is then multiplied by the maximum interest exclusion arrived at above. In our example Suzy would be permitted to exclude one-third of 80% of her interest.

How much interest are we talking about? Not much.

For the good of the country, Ben Bernanke is running off $100 bills and using them to cover the deficit. That pushes interest rates down. So the coupon on the savings bonds is 0.2%. Also, the most you can put into Series EE savings bonds in any one year is $10,000.

Twenty years at 0.2% sounds like only 4%, but there’s compounding. If Suzy invests $10,000, she earns $408 between now and 2033.

The benefit here is a tax holiday on a third of 80% of $408, or $109. In her tax bracket, Suzy will save $27.20, and she can use that windfall toward the cost of college.

Flat tax? Politically, it can’t happen. If there were a simple tax code Suzy would be out $27 and universities would be up in arms.

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William: for those with higher incomes (those subject to AMT), there is a much easier way to legally save paying tax on college savings.

You have – for example – $20,000 of securites, with a cost basis of $5,000. After all, you have been saving these funds for 20 years now and they have appreciated nicely. You and your wife gift these securities to your child. Child sells the securities and ends up with a $15,000 capital gain. Since he is 19 years old and a student, the kiddie tax kicks in at 15% and he has a tax liability of $2250. But since he is in college he claims the American Opportunity Tax Credit, offsetting the entire $2250 of income tax liability.

To claim the AOT, your child must claim his own personal exemption. This means the parent cannot do so….but since the parent is in AMT territory, losing the child’s exemption doesn’t cost anything at all in lost tax benefits.

The child uses the funds from selling the securities for college expenses. You could do this every year if it made sense for you (you were still in AMT, had highly appreciated securities to gift, etc.). The only issue would be in you had already stashed the full four years of college costs in a 529 account…as you would have to deal with a lot of stranded 529 money.

Bottom line – you saved for his college for 20 years, and you didn’t pay a cent in income tax on the appreciation.

The strategy outlined here is very astute, at least for the right upper-middle-income taxpayer. The person to benefit from the Wagnerian approach: –is an AMT victim. Typically, that means having an income below $500,000 and having the misfortune to live in a high tax state. –is sitting on appreciated securities and would like to sell. –has a son or daughter in college who isn’t eligible for need-based aid. –has an income too high to qualify for the full AOTC. That would be $160,000-plus.